Under the condition of open economy, there may exist pass-through of the exchange rate change to the buyer of the good, achieving the relative price change and providing the so-called expenditure-switching effect. There are several factors affecting the magnitude of the expenditure-switching effect, including the firm’s choice of pricing currencies, shipping costs, non-traded distribution services, price discrimination and imports as intermediates. These factors influence the magnitude of the expenditure-switching effect, and in turn influence the choice of exchange rate regimes. Take the firm’s choice of pricing currencies for example. If prices are sticky in producers’ currencies, nominal exchange rate changes can achieve the relative price change that is required between home and foreign goods. The nominal exchange rate flexibility provides the desired expenditure-switching effect of relative price changes. However, if prices are fixed in consumers’ currencies in advance, nominal exchange rate flexibility cannot lead to any relative price adjustment. In this case, nominal exchange rate fluctuations are undesirable for the reason that they lead to deviations from the law of one price. So there are no strong reasons in favor of floating exchange rate regimes if prices are sticky in this way. In stead, fixed exchange rates are optimal.
I also examine its implications for the RMB exchange rate regime. Recent years have witnessed strong appreciation pressures on RMB from economic and political aspect, especially from the United States that is afflicted by large trade deficit. From the perspectives of expenditure-switching effect of the exchange rate change, we conclude that there does not exist significant expenditure-switching effect of exchange rate change between RMB and USD and that the appreciation of RMB will have limited impact on the United States’ trade deficit and that the appreciation pressure mainly comes from political aspect. On the contrary, the appreciation of RMB may harmfully influence the capital item, causing financial crisis. So from the perspective of trade item, RMB should keep stable in the short run. However, in the long run, the advantages of RMB appreciation may outweigh the disadvantages with the growth of domestic economy. The appreciation of RMB helps to switch the demand out of raw products, thus leading to product upgrade and improving industrial core competency. The essential problem is how to form a stable and flexible exchange rate determination system.
I also examine its implications for the RMB exchange rate regime. Recent years have witnessed strong appreciation pressures on RMB from economic and political aspect, especially from the United States that is afflicted by large trade deficit. From the perspectives of expenditure-switching effect of the exchange rate change, we conclude that there does not exist significant expenditure-switching effect of exchange rate change between RMB and USD and that the appreciation of RMB will have limited impact on the United States’ trade deficit and that the appreciation pressure mainly comes from political aspect. On the contrary, the appreciation of RMB may harmfully influence the capital item, causing financial crisis. So from the perspective of trade item, RMB should keep stable in the short run. However, in the long run, the advantages of RMB appreciation may outweigh the disadvantages with the growth of domestic economy. The appreciation of RMB helps to switch the demand out of raw products, thus leading to product upgrade and improving industrial core competency. The essential problem is how to form a stable and flexible exchange rate determination system.